Apparently the
Canadians are worried. Think about how poor economic performance in the U.S. might affect Canada - specifically, what might happen to their net export demand? Does this matter if they have perfectly flexible exchange rates? How about if they have fixed exchange rates?
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In early March the central bank of Canada decreased interest rates due to a slowed growth rate of their economy. This is a result, in part, of the diminishing demand for Canada’s exports. The impetus for the rate cut came about for several reasons. One reason, the central bank states, is the looming recession in the United States. Canada claims that the domestic economy is steadfast, meanwhile the international trade side of the economy is hurting. With Canada’s dollar staying strong against the American dollar, U.S. citizens are less willing to buy Canadian products. Not to mention most American’s overwhelming and still growing debt. Another justification for the rate decrease is where Canada stands with inflation. Cuts in the interest rate usually lead to higher inflation, but Canada’s CPI inflation is below average so they can afford a little surge in prices.
When the Central Bank cuts the interest rate it is considered monetary policy. Canada’s bank believes that more monetary policy may be necessary in the near future to try and preserve their surpluses.
Looking at the Foreign Exchange Market, with flexible exchange rates, a decrease in Canada’s Net Export demand (NXe) will decrease the exchange rate. Which, for Canada, might help boost their NXe demand back up as their products become more affordable relative to the rest of the world (namely the U.S.). This decrease in NXe translates into the IS curve shifting inward in our IS/LM model. This illustrates the decline in exchange rates but there is no change in output. With Fixed exchange rates the same decrease in demand will put downward pressure on the exchange rate but a contractionary monetary policy (i.e. decrease the money supply) is necessary to keep the exchange rate at the desired level.
Interest rate (r) cuts in the foreign exchange market with flexible exchange rates will shift the I-Sr curve in and puch exchange rates up. this renders an IS curve shift outward in the IS/LM model. With that curve movement output will rise as well as the exchange rate (matching the increase in the Foreign exchange Market). With fixed exchange rates a decrease in r will also shift the S-Ir curve in putting upward pressure on the exchange rate. This shifts the IS curve out in the IS/LM, which will force some sort of expansionary monetary policy to be placed into effect in order to keep the exchange rate stable.
This article puts into perspective the international costs of a possible U.S. recession. Obviously being the largest and richest economy there should be some impact on the other countries that are tied to the U.S. economically. Hopefully Canada can successfully use monetary policy to boost export demand and thereby help economic growth, to prevent the fate that might befall the U.S. Too bad we’re too busy buying lead filled toys from China to help our neighbors to the north.
In this article “Canada cuts rates amid US fears” indicates The Bank of Canada cut its key interest rate by a half percentage point, citing a slowdown in Canada’s exports. The Bank of Canada may make deeper rate cuts this year because the U.S. reduction signals a worsening slowdown in that country, which is Canada's biggest export market. The cut is the third one since December, and the largest since September 11th. It is also the first rate reduction made by the new governor Mark Carney since taking over from David Dodge at the start of February.
The central bank expressed their fears over a US recession because of the effects of the weaker U.S. economic growth outlook will lead to additional downward pressure on export growth. According to Craig Wright, chief economist at Royal Bank of Canada believes Canada's export slowdown is going to get even bigger. The U.S. economy has cut the country’s exports which caused a 2.2 percent drop in the third quarter. This is the first decline the country has experienced in eighteen months.
Although the inflation conditions were favorable, the consumer price index was watched closely by the Bank of Canada. The inflation measure which excludes volatile items such as food and fuel was at 1.4 percent in January and the headline CPI inflation was at 2.2 percent. Canada’s finance minister Jim Flahery announced his government’s third balanced budget, yet there is much apprehension in weaker results since the balanced budget came out. Many people feel that the minister will be unable to keep his promises of a continued surplus. The central bank has scheduled the next rate change for April 22nd. There are supposed to be more capital incentives to decrease the possibility of further cuts.
In recent years, the demand for and the prices of Canadian commodity exports have been rising sharply. This has helped to create an economic boom, and investment flows into Canada have increased. Canada’s floating dollar has appreciated sharply and thus, has forced some necessary adjustments. The flexible exchange rate has again helped the economy to absorb shocks and has allowed the Bank of Canada to keep inflation near the 2 percent target. A flexible exchange rate regime has definitely helped Canada to maintain production close to full capacity and to minimize the effects of the boom-bust cycles in various sectors. A floating exchange rate can bring a number of important benefits. A well-functioning domestic financial system is crucial to achieving efficient domestic allocation of capital and to dealing with external shocks. Canada emphasizes the importance of a floating exchange rate regime, which is a key element in promoting good performance, both domestically and globally. For systemically important countries, Canada will continue promoting floating rates supported by well-developed and well-functioning domestic financial markets.
This is just more evidence that the United States economy has a direct reflection on the rest of the worlds’ economies. The Canadian CPI although small is soaring against the American CPI reported by Bryant in the article labeled “Inflation”. The cuts in interest rates have caused a drop in NX by 2 percent according to Ms. Lawrence. In order to stay competitive I do believe that we will begin to see more cuts by the Canadian Central Bank in days ahead.
We however are experiencing the gains against their losses so there is no dead weight loses, but rather a shift in more affordable goods because more people can now afford them.
While we have been running huge deficits, our Canadian neighbors’ have been running surpluses, thus causing and increase in the savings and investment curve. Shifting the IS curve forward or up and raising exchange rates.
The Canadians are basically pricing themselves out of the market and to counteract this the Canadian Central bank is wisely lowering interest rates.
After experiencing slower growth for the fourth quarter of last year the central bank of Canada decided to cut interest rates by half a percent to 3.5 percent. By doing this they hoping to encourage more spending to help grow the economy. After only a .2 percent growth for the fourth quarter and increasing fears of a US recession the central bank felt the decrease was in order. The central bank also cites to strength of the Canadian dollar compared to the US dollar which has recently be overtaken by the Canadian dollar. With a higher exchange rate, exports tend to decrease which is hurting the Canadian economy. The central bank will keep a watchful eye in the near future for further changes in monetary policy to further stimulate growth.
I would like to commend Canada in doing their du diligence in this harsh time in the US economy. The Canadian economy is so heavily tied to the US economy it is amazing how strong their dollar is and that the Canadian economy is not currently in a recession. What i currently wonder is about the CPI in Canada for their dollar is so strong but the prices of goods have yet to compensate. The best example is the price you see on almost ever magazine. The good for the US and Canada are the same but with different price tags, but as the Canadian dollar is now stronger than the US dollar their good are more expensive to buy. In the long run when the prices finally reflect the currency they should expect more growth, and as long as they closely monitor their monetary policy the central bank should be about to stimulate growth.
As the dollar falls and America demands fewer exports from foreign nations, notably from Canada, the Canadian banks cut the lending interest from 4 to 3.5 percent in a relatively short period of time. The problem exists with the less wavering Canadian dollar next to the more erratic US counterpart. American’s are retreating into more of an export climate to maximize on the power of a deficit and the ability to export more desirably in the foreign market, while Canada loses benefits from its own exports to the American consumer.
The next response is a slight inflation in Canada itself, but the CPI is consistent, so the market can handle the increase. Unfortunately, Canada still fears the backlash of the American recession for its future in trading exports. Though output is not changed, the exchange rate experiences a greater disparity. Canada does boast a strong home market though, which supplies an upside to the equation and potential allows time to go buy while America regains strength in the dollar (buy increasing its value in our own export market) and is able to buy a greater amount of Canadian exports once again.
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